How to Switch from Sole Proprietor to LLC: Everything to Know
How to switch from sole proprietor to LLC is a something that proprietors should know if they want to protect their personal assets from business liability.3 min read
How to switch from sole proprietor to LLC is a something that sole proprietors should know if they want to protect their personal assets from business liability or take on a new owner. A limited liability company (LLC) is a business entity that protects its owners from being held personally liable for its debts and lawsuits, while allowing them to pay company taxes at the individual level. Unlike a sole proprietorship, it can have multiple members, making it a good option for an expanding business. It is relatively easy to convert a sole proprietorship to an LLC.
Differences Between a Sole Proprietorship and an LLC
- Personal liability – If you are a sole proprietor, you will be held personally liable in the event of a lawsuit. An LLC, on the other hand, is a separate entity from you, so it will be held accountable when it faces a lawsuit or penalty.
- Taxation – An LLC provides more tax advantages than a sole proprietorship because it allows you to pay taxes in different ways.
- Employer Identification Number (EIN) – An LLC is required to obtain its own EIN and complete other paperwork because it is a separate entity.
- Number of owners – A sole proprietorship can have only one owner, but an LLC can have multiple members. However, you can organize your business as an LLC even if you wish to be the only owner. A single-member LLC functions in the same way as a multi-member LLC, except that it has only one owner.
How to Switch from Sole Proprietorship to LLC
Name Your LLC
If the name of your sole proprietorship is identical to the name of another LLC registered in your state, you cannot use that name for your new LLC. So, you need to come up with a unique name. You can find out if your chosen name is available by checking with the office of the Secretary of State. Many states have databases of registered LLC names on their websites.
If the name is available, you have to make sure that it does not infringe on someone else's trademark. You can do this by searching the trademark database on the website of the U.S. Patent and Trademark Office. Additionally, you are required to include “Limited Liability Company,” “Liability Co.,” “LLC,” or an equivalent term or abbreviation in your business name.
File the Articles of Organization
In order to form an LLC, you must file the Articles of Organization with the Secretary of State. This document typically includes the following information:
- Name of your LLC
- Address of your LLC
- Purpose of your LLC
- Name and address of your LLC's registered agent
- Indication of whether your LLC will be managed by members or managers
Draft an Operating Agreement
In some states, it is mandatory for an LLC to draft an operating agreement. An operating agreement is a document that describes the ownership and management of an LLC. It usually includes details such as:
- Each member's ownership percentage
- Voting rights of members
- Method of distributing profits and losses among members
- Actions for dealing with the departure of a member
Obtain an Employer Identification Number (EIN)
You are also required to obtain a new EIN from the IRS, even if you had one as a sole proprietor. An EIN can be used for a number of purposes, including handling payroll, filing taxes, opening a business bank account, and getting business credit.
Open a New Business Bank Account
The next thing you need to do is open a new business bank account in your LLC's name, using your new EIN. A business bank account can help you keep your personal and business funds separate, so that you can shield your personal assets from business liability and streamline your records for tax reporting.
Get the Necessary Business Licenses and Permits
You may be required to obtain certain business licenses and permits in order to operate your LLC legally. Some examples of licenses and permits you may need include a professional license, health permit, or reseller's permit. Contact the office of your local government to find out if you need to apply for a business license or permit.
If you want to learn how to switch from sole proprietor to LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.